IMF's yuan decision: why it matters and why some are not pleased

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On the 30th of November, the IMF announced its decision to include the Chinese yuan in the Special Drawing Rights (SDR) basket.

Terrific, I hear you say, yet another TLA to understand (Three Letter Acronym). Bear with me. I could go through the technical details of how it all works, but I suspect my readership would plummet so here's the quick version. SDRs are not a currency; rather, they are used as a book-keeping entry. When a country borrows from or through the IMF, that loan is recorded as a loan of SDRs, though what the country actually receives is a hard currency. Other international organisations use SDRs in this way too. SDRs also function as an asset at the IMF (Wait, they are a book-keeping entry and an asset? Yep, just like the dollar). Countries have a certain amount of SDRs allocated to them by the IMF. Countries can exchange these for currencies with other IMF members. For more details check out the IMF worksheet. If you want a gold star and to see how SDRs are used in the plumbing of IMF lending, then the FT has the page for you.

Right, hopefully that’s all clear. So what is the significance of the yuan inclusion? In and of itself, not much. Inclusion is not going to lead directly to more trading or use of the yuan, apart from perhaps at the IMF itself. The FT also has a nice piece deflating some of the hype surrounding SDR inclusion

Inclusion can, however, also be viewed as the IMF’s tick of approval.

In August, the IMF released a report that examined, in detail, the case for the inclusion of the yuan. A sticking point was whether the currency was 'freely usable', a somewhat rubbery concept that is one of the IMF's criteria.

Since that report was published, the Chinese have made some changes, perhaps with the aim of addressing this issue. For example, they have taken steps to allow the market more influence on the value of the exchange rate, and they have allowed official institutions to have direct access to bond and foreign exchange markets. That seemed to be enough for the IMF. And perhaps, economically speaking, these reforms by the Chinese are the bigger story here.

But not everyone is happy. Ted Truman, long-time Federal Reserve employee and also former assistant secretary of the US Treasury, has criticised the decision making process. In particular, he is worried the decision was politicised:

Christine Lagarde appears to have decided to give the Chinese authorities the political trophy of inclusion of their currency in the SDR basket and to take personal credit for this action. She has announced her position on the SDR basket two weeks in advance of its review by the executive board. Thereby, she has exerted pressure on the members of the executive board and on officials in the capitals of the countries they represent to agree with her.

Given the problems other IMF reforms are facing — in particular the reforms that would increase the voting share of China, which are held up in the US Congress — some may be tempted to give the Chinese some leeway. However, unequal treatment is a dangerous game to play, and I hope those in charge have not succumbed to the temptation.

The stakes – who gets to construct the legal, economic, and military architecture of an integrated Indo-Pacific region – are enormous. Without bold policy from the US and India, the answer will be China.